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East Africa hosts several opportunities for Islamic finance to thrive. The region is home to a burgeoning Muslim customer base which presents significant demand for Islamic finance products and services, as well as offers substantial opportunities to develop and deepen the existing ecosystem.
However, the industry has struggled to realise its potential owed to several challenges, including regulatory gaps and a lack of adoption stemming from limited awareness and education.
On balance, East Africa is an economic powerhouse, hosting some of the fastest growing economies on the continent. It is forecasted to lead Africa’s economic pulse, with growth projected to scale from 3.5% in 2023 to 5.1% in 2024 and 5.7% in 2025, according to an Africa Development Bank (AfDB) report. Seven economies in the region are projected to grow 5% or more in 2024, it adds.
Similarly, East African nations are seeking to develop relations with Gulf countries both in terms of trade and foreign direct investment (FDI). GCC countries have collectively invested more than $100 billion in Africa over the last decade, while GCC companies announced 73 FDI projects worth $53 billion in Africa last year.
Yet, despite potential opportunities for Islamic finance in the region, the past decade has yielded mixed results, according to analysts.
Islamic finance faces a lot of challenges in East Africa, according to Samira Mensah, director and lead analyst Africa, financial institutions & sovereign ratings at S&P Global.
“There has been robust headline economic growth, but external shocks, high level of sovereign debt and debt service costs have hindered public finances and investments.”
Kenya
Islamic finance has been active in Kenya since the 1990s. In 2017, the government pledged to offer Islamic finance a bigger chunk of the country’s financial infrastructure.
Key Islamic banks include Gulf African Bank, Premier Bank (previously First Community Bank) and Dubai Islamic Bank. Meanwhile, conventional lenders like Absa Kenya, National Bank of Kenya and Kenya Commercial Bank, operate Islamic banking windows.
But S&P’s Samira Mensah believes that Islamic finance in Kenya over the last decade has been a disappointing story.
“The industry has faced several challenges including weak public finances and indebtedness. Nonetheless, Kenya has the legal framework that caters to Islamic finance, which should attract foreign investors.”
Saad Rehman, CEO at Salaam Investment Bank in Kenya, adds that the actual adoption of Islamic products among Kenyans remains an open question.
“It depends on the age group of consumers. With the older generation, it will be harder,” he says. “There is movement from younger millennials while Gen Z is demanding Islamic products.”
There is room for optimism in the capital markets space. Linzi Finco, a subsidiary of Liaison Group, sold the country’s first sukuk this August. The 3 billion Kenyan shilling ($23 million) 15-year sukuk offers a profit rate of 11.13%. The listed debt will be used to fund the construction of over 3,000 affordable institutional housing units, supporting the Kenyan government’s affordable housing agenda.
However, Mensah remains sceptical on corporate sukuk issuances, adding that Kenya’s capital markets are neither deep nor broad and are largely animated by sovereign issuance.
“Banks in Kenya are reliant on customer deposits to fund their lending operations. Rather they rely on development banks for foreign currency funding. We haven’t seen much corporate issuance in the conventional space,” she says.
A more positive area could be within Kenya’s fintech sector. S&P notes 80% of the country’s adult population used mobile money service providers for money transfers in 2022, compared to 44.1% for banks. The fintech ecosystem is spread across four key sectors: payments and remittances, lending, finance business administration and insurance.
“I think there is a lot of potential for technological solutions like fintech and tokenization in East Africa,” says Rehman. “Technology can democratise Islamic financial services and products like retail sukuk.”
Tanzania
Tanzania introduced Islamic banking in 2008, allowing lenders to offer Shariah-compliant products to a large Muslim population, estimated to comprise 35-40% of the total resident base of over 61 million.
Aman Bank is Tanzania’s first fully-fledged Islamic bank, while conventional lenders like National Bank of Commerce operate an Islamic window.
Whilst the country permits Islamic banking, there is no specific regulatory framework. However, the East African nation is developing its Islamic finance industry beyond banking. For example, in April 2022, Tanzania’s insurance regulator issued guidelines on takaful activities.
Although there has yet to be a sovereign sukuk issuance, Imaan Finance, a local financial services provider, sold the country’s first sukuk worth 2.72 billion Tanzanian shilling ($1.17 million) in 2021.
Salum Awadh, CEO, Shirkah Asset Management, believes sukuk issuances are increasing, awareness is growing, and the industry is gaining traction.
“[In particular]we have seen the launch of two takaful operators, an asset-backed sukuk, as well as the first halal mutual fund and sukuk guidelines have been issued,” he notes.
Awadh also identifies challenges such as tepid education and awareness levels as significant barriers to growth.
“We really need to invest here; then the enactment of Islamic banking regulations will be a key opener. We need more investment products in the market, and the use of technology through fintech will disrupt the traditional paths to stimulate faster growth through innovation, increasing access, and lowering costs.”
Uganda
Uganda’s nascent Islamic finance sector is slowly becoming part of the country’s financial ecosystem. Muslims constitute around 14% of the country’s population of about 47 million.
In 2016, the Bank of Uganda, the country’s central bank, began working on legislative amendments to introduce Islamic banking.
In September last year, Bank of Uganda granted its first Islamic banking license to Salaam Bank Uganda, a subsidiary of a Djibouti-based bank. Saudi-headquartered Islamic Development Bank (IsDB) has also established a regional hub in Kampala, responsible for overseeing its activities in Uganda as well as in Comoros, Djibouti, Mozambique, and Somalia.
Its fintech sector is beginning to expand, too, with companies like Thiqa Digital Finance, offering Shariah-compliant products such as payments, asset financing, and trade finance.
Ethiopia
The National Bank of Ethiopia authorised commercial banks to offer interest-free banking windows within its conventional banking system in 2011. In 2019, authorities expanded the framework to enable fully-fledged Shariah-compliant lenders.
ZamZam Bank, the first Islamic lender in Ethiopia was established in 2020, followed by Hijra Bank a year later. Conventional banks like Commercial Bank of Ethiopia and Abay Bank, continue to offer Shariah-compliant services through Islamic windows.
Nonetheless, lack of managerial expertise and regulatory gaps in areas like takaful, sukuk, and Islamic capital markets, remain. S&P’s Mensah adds that markets like Ethiopia and Madagascar face their own [economic] challenges, which makes it difficult for Islamic finance to develop.
“In Ethiopia, the sovereign defaulted on its Eurobond and the financial sector is to a large extent public sector led,” she says.
However, the Ethiopian Securities Exchange is reportedly looking to develop Shariah-compliant capital market products.
Djibouti
In 2011, the government introduced its Islamic banking law, followed by takaful legislation a year later. Furthermore, in October 2016, it established a National Shariah Council to oversee the sector. However, it does not have a sukuk law in place and currently does not borrow from international capital markets.
The Central Bank of Djibouti is an AAOIFI regulatory member and a full IFSB member. Djibouti is a member of the IsDB, too. Islamic banks operating in Djibouti include Dahabshil Bank International, East Africa Bank, Salaam Bank, Saba African Bank, and Shoura Bank.
Conventional lenders like Djibouti International Bank, operate Islamic banking windows.
Collectively, these banks are estimated to hold between 15% and 20% of the local financial market.